Bernanke’s Clever Ruse

It’s official. The Bernanke Fed has gone mad. Less than 24 hours after the biggest stock market sell-off of the year (a scant 1.5% drop) Bernanke & Co. are out floating trial balloons on possible QE3 mechanics to remind investors that a third round of money printing is still on the table. The intention is, as usual, to prop up the stock market. The Fed is trying to setup a no risk proposition for investors. If the economy weakens, the Fed will print more money to prop up stocks. If the economy strengthens, the hope is that the stock market will rally on improving economic data.

Federal Reserve officials are considering a new type of bond-buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.

Sterilized money printing is nothing more than a clever ruse to keep the political heat off of the Fed. Swapping reserves for short-term loans will not sterilize another round of money printing. Instead of holding cash reserves on their balance sheets, banks would own risk-free short-term loans which most analysts consider a cash equivalent. Liquidity would still flood into the financial system, and inflation risk would still rise.
This is yet more scorched earth monetary policy from Bernanke. Flood the financial system with liquidity to temporarily boost employment, regardless of the destructive long-term consequences for the American economy. Sustainable improvement in the labor market cannot be created with unsustainably loose monetary policy.

Investors not focused on the Fed’s historic financial market distortions may be unknowingly taking unwise investment risks. When (maybe if) the Fed stops propping up asset prices, financial market turbulence are likely to pickup. Stay focused on the Fed. Bernanke’s actions this week are a reminder that Fed policy is still the key driver of stock market performance.

Jeremy Jones, CFA

Jeremy Jones, CFA is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Jeremy is a contributing editor of youngresearch.com.